A commodity is a basic good that can be bought and sold. The purchase and sale of commodities is usually carried out through futures contracts on a commodities exchange.
A commodity has no or hardly any differentiation – one ounce of gold is the same as any other ounce of gold.
Examples of commodities include gold, silver, iron ore, copper, wheat, rice, coffee beans, sugar, salt, etc. Soft commodities are goods that are grown, while hard commodities are extracted from mining. Energy commodities include crude oil, coal, natural gas, electricity, etc.
- Exposure to different growth opportunities. A growing demand in a commodity can see its prices rise significantly over time. For example, iron ore prices rose by more than three times in 2008-2010 driven by huge demand in China and its supercharged economic growth.
- Diversification benefits. Commodities have historically shown a low or negative correlation with stocks and bonds. If you’re looking to hedge against your stock and bond investments, investing in commodities might interest you.
- Protection against inflation. While inflation weighs down your stock and bond investment returns, commodities usually benefit from inflation. Because when the price of goods and services rise, the prices of commodities needed to produce these goods and services will rise in tandem.
- Highly volatile. Commodities are one the most volatile asset classes around. In one analysis, commodities are twice as volatile as stocks and nearly four times as volatile as bonds. This extreme volatility makes commodities risky for certain investors.
- No income generation. Unlike other asset classes, commodities don’t generate any income for the investor.
Read the Full Series:
The Pros & Cons of Investing in Stocks
The Pros & Cons of Investing in Bonds
The Pros & Cons of Investing in the Money Market
The Pros & Cons of Investing in Real Estate
The Pros & Cons of Investing in Commodities